Turning risk into results

Turning risk into resultsWhat are today’s top risks and opportunities for power and utility companies? And how can they best mitigate and capitalize on these to drive growth and ensure long-term sustainability? Keith Harrison reports.

Ernst & Young’s Business Pulse for power & utilities is our snapshot of the power and utilities (P&U) industry today and a forecast ahead to 2015. Drawn from interviews with the world’s leading utilities, it offers insight into the biggest challenges facing a sector undergoing massive transformation.

A shift in thinking is evident in this year’s report. It is clear that utilities recognize that their traditional business model is under threat and that new approaches are needed to achieve future success.

Regulatory pressures top risksThe fast-paced change of regulatory and compliance criteria ensure this is the top risk for utilities now and into the future. In established markets, these regulations are driven by market reforms and a move toward competition in all aspects of utility operations. In emerging markets, regulation is increasing as the sector grows to keep up with energy demands. The challenge for utilities is to better manage their regulatory obligations by keeping abreast of frequent changes and effectively communicating with stakeholders about how these will affect prices.

Ongoing economic volatility may be accepted as “the new normal,” but it remains a challenge for utilities. Commodity and emissions market uncertainties add risk to utility investment planning, as do fluctuations in energy and climate policy. In developed markets, aging infrastructure and the low-carbon agenda will require vast amounts of capital expenditure, while in developing markets, the growing demand for energy is the principal driver behind the need to invest heavily in capital assets. Companies will need to carefully consider how they will access new sources of capital — beyond the banks — to finance their future investment needs.

Emerging markets lead opportunitiesUtilities continue to see emerging economies as their top opportunity. The International Energy Agency forecasts non-OECD economies, particularly China and India, to grow the most rapidly in coming years. China’s demand is forecast to rise 60% by 2035, while India’s is set to more than double. Opportunities in emerging markets are not just of interest to utilities from developed markets, as demonstrated by Chinese power company investment in South America.

Top 10 risks 2013 ranking

2015forecast

Compliance and regulations 1 3

Commodity price volatility and access to competitively priced long-term fuel supplies

2 2

Political intervention in P&U markets 3 1

Uncertainty in climate policy and carbon pricing 4 4

Significant shifts in the cost and accessibility of capital 5 5

Capital project execution 6 6

Economic shocks and resulting short-term energy demand shocks 7 7

War for talent 8 8

Aging generation and network infrastructure 9 10

Managing planning and public acceptance 10 9

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As utilities move to capitalize on the potential of emerging markets, they face the challenge of mitigating the inherent risks of overseas expansion. Foreign markets can be complex to navigate, and a local presence is key to understanding the regulatory, political and cultural frameworks.

Using an acquisition or alliance to develop new capabilities, move into emerging markets and spread the cost — and risk — of large-scale capital projects is seen as a growing opportunity for utilities. But decisions regarding these transactions are complex, and utilities will need to engage with the right expertise as they plan and implement any merger or acquisition.

Many of the risks facing power and utility companies are largely beyond their control and can only be mitigated by contingency planning and damage minimization. Other challenges, such as the relationships with customers, offer opportunities to make real change and reap a competitive advantage. We expect the smart revolution to play a major role in realizing this opportunity. Access to near-real-time data from smart meters opens the door for utilities to build better relationships with customers and to move toward selling new services and solutions.

Utilities may see regulatory pressures as their biggest risk, but interestingly, many also recognize that improving relationships with regulators may offer one of their greatest opportunities. Building stronger,

more trusting relationships with regulators can minimize the risk of non-compliance and enhance a power and utility company’s ability to influence the rules.

New challengesApart from the top 10 risks identified by utilities, several other emerging challenges warrant attention. Two of these are likely to have a significant impact on utilities:

Disruption of the traditional utilities value chain: although the dominance of the vertical utility chain is being eroded by evolving regulatory regimes and new entrants, the time frame for change is unclear. Large utilities still control the majority of customers, but regulators may force change to encourage competition. And, as consumers gain more control through technical innovations, they may

also vote with their wallets.

Ineffective energy storage solutions: the high cost of existing storage solutions makes their large-scale rollout unlikely, while some question whether a major expansion of energy storage is even required — demand response programs or reserve capacity could resolve many of the relevant issues. And, as the structure, operation and regulation of electricity markets will ultimately shape incentives to build storage, this creates a significant political or regulatory risk for potential developers or funders of these projects.

Be ready to respondBoth the top risks and opportunities reflect the evolving nature of energy production, delivery and supply, as well as the arrival of new and innovative market participants. They drive home the need to assess your company’s business model and strategy to ensure its readiness for the sector’s transformation. In an increasingly competitive, globalized world, utilities that are aware of the risks and opportunities they face — and have strategies in place to respond — stand the best chance of success.

Read the full Business Pulse for power & utilities here.

Top 10 opportunities 2013 ranking

2015forecast

Rising emerging markets’ energy demand 1 1

Acquisitions or alliances to gain new capabilities 2 2

Growth in energy and ancillary services markets 3 3

Enhancing relationships with external regulatory and compliance bodies 4 4

Improving public perceptions 5 9

Increased focus on investor relations programs and communications 6 5

Integration of distributed energy resources 7 8

Increased investment in generation capacity and delivery infrastructure in emerging markets

8 7

Rising energy innovation in emerging markets 9 6

Improving onshore and offshore wind supply chain efficiency 10 10

Keith Harrison Lead Analyst, Global Power & Utilities Center + 44 77 6099 1110 kharrison@uk.ey.com

Keith joined Ernst & Young in April 2012, following four years as a research director and analyst with IT research and advisory firm Gartner, where he focused on technologies associated with energy and utility company operations. Before Gartner, Keith worked in the P&U sector in the UK and North America for 15 years.

3 | Turning risk into results

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About Ernst & Young’s Global Power & Utilities Center

In a world of uncertainty, changing regulatory frameworks and environmental challenges, utility companies need to maintain a secure and reliable supply, while anticipating change and reacting to it quickly. Ernst & Young’s Global Power & Utilities Center brings together a worldwide team of professionals to help you achieve your potential — a team with deep technical experience in providing assurance, tax, transaction and advisory services.The Center works to anticipate market trends, identify the implications and develop points of view on relevant sector issues. Ultimately it enables us to help you meet your goals and compete more effectively. It’s how Ernst & Young makes a difference.

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